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The 3d U.S. Circuit Court of Appeals has rejected a corporate defendant’s “pre-packaged” bankruptcy plan that would have resolved all of its outstanding asbestos claims by establishing a $1.2 billion trust. In re Combustion Engineering Inc., No. 03-3392 The decision is the first appellate court ruling on a growing trend among asbestos defendants to prepackage a bankruptcy by filing a reorganization plan that has already been voted upon by impaired creditors. According to the 3d Circuit, the process used by Combustion Engineering Inc. to confirm the plan may have been unfair because it was approved by a group of asbestos claimants who had already been paid 95% of their claims. Other claimants, however, would have recovered as little as 18%. The 3d Circuit ordered extensive hearings and fact-finding on issues related to the plan’s fairness. Chief Circuit Judge Anthony J. Scirica said that Combustion Engineering, by winning approval from a group of creditors with only a fragment of claims outstanding, may have violated a provision of the Bankruptcy Code that allows for the establishment of a trust to pay off asbestos claims. “This type of manipulation is especially problematic in the asbestos context, where a voting majority can be made to consist of non-malignant claimants whose interests may be adverse to those of claimants with more severe injuries,” he wrote. He found that since some of the asbestos claimants received as much as 95% of the full liquidated value of their claims, they had “little incentive to scrutinize” the terms of the proposed plan. In the fall of 2002, Combustion Engineering tried to resolve its asbestos problems, through a prepackaged Chapter 11 bankruptcy reorganization. The company contributed half of its assets to a prepetition trust to pay asbestos claimants with pending lawsuits for part of their claims. The unpaid portion of these claims, known as “stub claims,” provided prepetition trust participants with creditor status under the Bankruptcy Code. Combustion Engineering then filed a prepackaged bankruptcy plan, which would channel all of the asbestos claims to a post-confirmation trust created under � 524(g) of the Bankruptcy Code. The trust paid the first group 95% of the agreed value for their claims, the second group 85% and the third group 75%. As a result, each claimant was left with an unsecured stub claim that ultimately was impaired under Combustion Engineering’s soon-to-be-filed bankruptcy plan. Under the plan, a trust was established to satisfy the stub claims left over from the prepetition settlement trust and all future asbestos claims, thereby insulating Combustion Engineering from asbestos claims going forward. The lower courts approved the plan. Now the 3d Circuit has ruled that the bankruptcy court must take a closer look at conduct, which, according to Scirica, “potentially allows a debtor to manipulate the Chapter 11 confirmation process by engineering literal compliance with the code while avoiding opposition to reorganization by truly impaired creditors.”

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